Founders are often told to price based on the value they are providing to their customers. For example, if you’re saving your customer 1 million dollars, charge a 10th of that. Here’s Kevin Hale at YC advocating for this approach:
In startups, and almost pretty consistently across all businesses, everyone will tell you, you should strive for value-based pricing. It allows you to charge a whole lot more. It allows you to manipulate this incentive to buy.
If we’re just talking about the short-term, this is good advice. Over the long-term, the situation is more complicated.
First, if you don’t have strong network effects, high switching costs, or economies of scale, then the increased margin you get from value-based pricing is — to paraphase Jeff Bezos — someone else’s opportunity to disrupt you. A high-margin business can get fat and slow and unable to muster the will to do the deep cuts to compete with an upstart on price.
Second, the relative power of your economies of scale, network effects, and switching costs are a function of your market share. When you use value-based pricing early on in your startup’s journey, you’re hamstringing your growth and your ability to gain these important sources of sustainable competitive advantage. All other things equal, a more savy startup that sticks to cost+ pricing to penetrate the market more quickly will get these competitive advantages faster and win.
Now, some caveats.
Investors like to see big margins, and you may need to prove that you can sustain high margins in a subset of your deals to make them happy and raise another round, but applying value-based pricing to every deal is overkill.
Moreover,you may be selling a very price-inelastic product in which case higher prices won’t meaningfully slow your growth rate. Value-based pricing is fine here, but unless your first to market — something that is increasingly difficult to do after decades of VC being dumped into software — this probably isn’t you.
But what the hell do I know? I’m currently in the process of winding down a failed startup, so I might be full of shit. Here’s a more certain truth: Josh Shroyer, our founding engineer is a hell of a catch, and you should hire him if you can. I wrote about why he’s great here. Feel free to email me with any questions ([email protected]) or contact him on LinkedIn.